Explained: Why many low-income Indian households still rely on moneylenders

India's financial inclusion story has moved forward in many ways over the past decade. More people have bank accounts, digital payments are part of daily life, and fintech has made financial services easier to access. But for many low- and middle-income households, especially those earning under Rs 5 lakh a year, borrowing money remains a challenge. When cash runs short, they still turn to the local moneylender, the nearby shopkeeper, or friends and family.Formal banking may have reached their neighbourhoods, but formal credit hasn't. A new report from Piramal Enterprises, based on CMIE's Consumer Pyramid Household Survey, brings this gap into focus. The report, authored by Debopam Chaudhuri, Chief Economist, Piramal Enterprises, shows that while access to the banking system has grown, access to credit remains uneven and out of reach for many.Among low-income households, informal loans are still far more common than formal ones. In 2021, these households borrowed 2.6 times more from informal sources than from banks or NBFCs. For comparison, that ratio is 0.6 in Brazil and just 0.27 in the US.
(Insights from Piramal study)
INFORMAL LOANS ON THE RISEThings look even more worrying for those at the bottom of the income ladder. Households earning under Rs 2 lakh a year saw formal borrowing fall by over 4% a year between FY19 and FY23. Informal borrowing in the same group grew by almost 6% each year.Even in the Rs 2–10 lakh range, more households are turning to both formal and informal credit. In other words, banks aren't replacing moneylenders; they're just another option, often not the first.What explains this persistent pull of the informal credit system?One big reason is that many borrowers simply don't fit into the banking system's boxes. They don't have stable jobs, payslips, or a strong credit history.When the pandemic hit, reverse migration increased the number of people in agricultural and informal work — jobs that banks view as risky. These workers needed credit, but banks stepped back. Informal lenders moved in, as they always have.The problem is that borrowing informally often comes with steep costs. Interest rates are high, there are no clear rules, and if things go wrong, there's little protection. It can trap families in cycles of debt that are hard to escape.Geography also plays a role. Southern states like Kerala, Tamil Nadu and Karnataka have higher levels of formal borrowing, partly due to the popularity of gold loans and wider fintech use. But in states like Bihar, Jharkhand and West Bengal, more than half of all households still depend on informal sources. Even Punjab, which traditionally had a more stable credit profile, is now seeing a shift towards informal loans.Occupation matters too. Daily-wage workers are among the most excluded. Over 55% of households in this group rely on informal loans, as banks tend to see them as too risky. The same is true for many self-employed people, especially those running small businesses. Banks often hesitate to lend to them. As a result, more of these households depend on non-institutional credit.On the other hand, salaried professionals and industrial workers have seen better access to formal loans, especially with the rise of digital lending platforms. These borrowers usually have more paperwork, better credit scores, and more predictable income. That makes them more bankable.NBFCs and microfinance institutions are filling some of the gaps, especially in small towns and rural areas, added the report. But their growth has limits. They face higher funding costs, tighter regulations and less room to scale.As Debopam Chaudhuri notes in the report, 'India's financial inclusion story has delivered impressive gains in access, but the next chapter must focus on usage, especially timely, affordable and appropriate credit. For millions of informal workers, small entrepreneurs and rural households, NBFCs are the only bridge to formal finance. Strengthening them is essential to close the credit gap.'He adds, 'Without formal credit at the last mile, especially for self-employed and blue-collar workers, India risks widening the credit divide. Informal borrowing not only carries higher costs but lacks regulatory protection, which undermines long-term household resilience.'The Piramal report calls for more support to strengthen these lenders, suggesting measures like giving strong NBFCs more options to raise funds, improving their access to affordable capital, and simplifying the rules around loan recovery for small borrowers. These steps could help them reach more people who are currently left out of the formal system.
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